Block Venues, SIs Big Liquidity Winners as MiFID II Begins Year Two

Block Venues, SIs Big Liquidity Winners as MiFID II Begins Year Two

Posted on Wed, Mar 6, 2019 @ 7:00

By Tim Cave, TABB Group
Originally published on the TABBFORUM

The liquidity makeup of the European equities market appears to be assuming something of a holding pattern, with the dramatic shifts experienced in the first few months of MiFID II during 2018 unlikely to be replicated. But some important trends continue to play out in market microstructure. TABB Group analyst Tim Cave looks at the growth of block platforms and systematic internalizers as Europe’s new rulebook enters its second year.

European equity trading started the year slowly, with January volumes down 12% year-over-year and 8% from December 2018.

It also feels as if the liquidity makeup has assumed something of a holding pattern, with the dramatic shifts experienced in the first few months of MiFID II during 2018 unlikely to be replicated. Changes over the course of this year are likely to be more gradual; that said, some important trends are continuing to play out in market microstructure. We take a closer look at two areas of the post-MIFID II landscape in this month’s volumes review: block venues and systematic internalizers (SIs).

MiFID II’s desire to preserve dark trading primarily for block-sized transactions has been one of the rulebook’s success stories. The growth in trades meeting the large-in-scale (LIS) thresholds has played out both before and after the introduction of the rulebook. Average daily notional in trades exceeding the LIS thresholds stood at €1.12 billion in January 2019, compared with €1.05 billion in December 2018 and €658 million in January 2018 – highlighting the market’s overall growth. Block volumes have stabilized at around 35% of dark volumes and 3% of overall order book volumes. This compares with 16% and 1.5%, respectively, two years ago.

Exhibit 1: LIS Market Share of Major E.U. Block Venues

Source: TABB Group European Equities LiquidityMatrix and big xyt

But perhaps the bigger story within these figures has been the rapid growth of Cboe’s LIS block venue, a relative newcomer compared to the platforms run by Liquidnet, ITG Posit and Turquoise Plato Block Discovery. Cboe LIS is now the second-largest block venue, accounting for 22% of Europe’s LIS market, and has seen larger volumes than Liquidnet (the top block platform by volume, with a LIS market share of 28%) on several days so far in 2019. Furthermore, Cboe LIS is now experiencing larger average execution sizes than the Liquidnet platform (see Exhibit 2, below). Interestingly, both platforms have seen their average execution sizes steadily fall under MiFID II, from more than 1 million to around 840,000 for Cboe LIS and 700,00 for Liquidnet.

Exhibit 2: Average Execution Sizes on Cboe LIS and Liquidnet

Source: TABB Group European Equities LiquidityMatrix and big xyt ​​​​​​​

Given recent news reports that Cboe may acquire US block trading platform BIDS Trading – which has partnered with Cboe on its LIS platform and provides the underlying buy-side desktop software – it will be interesting to see how the block market develops over the course of this year.

Systematic Internalizers

Systematic internalizers, the execution channel for trades completed off-exchange using a firm’s principal risk, have also grown strongly under MiFID II. The rulebook’s new share trading obligation, which effectively banned broker crossing networks (BCNs), strongly promoted the use of the SI regime when banks use their own capital to execute client trades. Non-bank, electronic liquidity providers (ELPs) have also been attracted to the SI regime to undertake market-making activities in a MiFID II-compliant manner. Addressable SI daily notional increased to €7.5 billion in January, representing 13% of overall activity, compared with €7.3 billon in December 2018, which represented 11% of overall activity. Prior to MiFID II, SI volumes were virtually non-existent.

As TABB Group has stated before, we believe this growth is being primarily driven by SI activity below the LIS thresholds, which in turn is being mainly driven by the growth of SIs run by ELPs (see Exhibit 3, below). Bank SI activity – which we assume mainly to be SI activity above the LIS thresholds – has shown no consistent trend since MiFID II’s introduction.

Exhibit 3: Addressable SI Volumes in E.U. Equities

Source: TABB Group European Equities LiquidityMatrix and big xyt ​​​​​​​

Average daily notional among the six ELP SIs which report to TABB (Tower Research Capital, Jane Street, Citadel Securities, XTX Markets, Hudson River Trading, and Virtu Financial) was €1.12 billion in January 2019, compared with €1.01 billion in December 2018. On the basis that all ELP SI activity is below LIS thresholds – which is supported by anecdotal evidence and RTS 27 reports – then ELP SI activity accounts for around 40% of below-LIS SI activity.

The challenge now for many banks and buy-side traders – as well as ELP SIs – is to find a consistent scoring mechanism to rank ELP SI liquidity for different scenarios. Each ELP SI offers unique liquidity and market-making strategies, and therefore there are some strong divergences in performances – based on metrics such as markouts, fill rates, and average order sizes. Finding a consistent method to rank ELP SIs is likely to be a focus in the early part of this year.

All these changes and more are covered in TABB Group’s exclusive “European Equities LiquidityMatrix January 2019,” which provides the industry with breakdowns of market share for each major equity execution channel, including lit venues, dark MTFs, block venues, periodic auction books and systematic internalisers. Please contact TABB Group for more information.